Wednesday, July 23, 2008

I believe that having a good solid plan is essential in achieving one’s goals. And my goal is to create an increasing stream of dividend income, which would allow me to live off of my investments.

There are several points that have to be covered: Strategy, Stock Selection, Diversification and Money Management.

Today I will be focusing on strategy. My strategy involves buying quality dividend stocks at bargain prices. Dividends have been largely ignored by investors during the 1990’s when internet stocks were increasing across the board. Dividends however are an important part of the total return of stocks as they have contributed almost 40% of the annual total returns in the S&P 500 over the past eight decades. In addition to that, I believe that a stock which pays a dividend gives at least some certainty that the investor will generate a return on their investment. Although it could be argued that there is always the possibility that the dividend may be cut, companies tend to cut the dividends as a last resort of action. Thus I believe that the dividend component provides some stability in income for investors who want to live off of their holdings. Stock price increases on the other hand are more difficult to predict.And last but not least, a company that has committed to paying a dividend shows its confidence that it will be able to generate a sufficient amount of profits to be distributed to shareholders.

We all learned from Enron and WorldCom that earnings could be manipulated easily. Manipulating the cash situation in a company is more difficult to achieve, because it cannot be created out of thin air. If a corporation does not have a very solid financial position, it won’t be able to commit to a dividend payment. An example of a company that hasn’t committed to paying dividends is PLA. Over the past 20 years, its shareholders have had a wild ride with the stock rising until 1999 and then declining. In comparison to PLA, GM shareholders had a much better total return over the same period.

As a general rule I would consider selling stocks which either cut their dividends or eliminate their dividend altogether.

I am generally looking for a blend of high growth lower yield stocks in addition to higher yield lower growth ones. I won’t be simply chasing yield, which represents a fixed dividend or worse a decreasing dividend.

An important part of my strategy is minimizing expenses. By opening a low cost brokerage account like Zecco or Sharebuilder I would be able to do that. In addition, if I can keep my expenses less than 0.5% per year, that would provide me with better long-term returns.

Disclaimer

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Questions or Comments? You can contact me at dividendgrowthinvestor at gmail dot com.